IN DEAL, NEW AUTHORITY OVER WALL STREET / THE NEW YORK TIMES ( VERY HIGHLY RECOMMENDED READING )

June 25, 2010

In Deal, New Authority Over Wall Street

By EDWARD WYATT and DAVID M. HERSZENHORN

WASHINGTON — An overhaul of the nation’s financial regulatory system, reached after an all-night Congressional horse-trading session, will vastly expand the authority of the federal government over Wall Street in a bid to curb the free-wheeling culture that led to the near collapse of the world economy in 2008.

The deal between House and Senate negotiators, sealed just before sunrise on Friday, imposes new rules on some of the riskiest business practices and exotic investment instruments. It also levies hefty fees on the financial services industry, essentially forcing big banks and hedge funds to pay the projected $20 billion, five-year cost of the new oversight that they will face. And it empowers regulators to liquidate failing financial companies, fundamentally altering the balance between government and industry.

But after weeks of intense lobbying and months of debate, Congress in the end stopped short of prohibiting some of the practices that led to the crisis two years ago, betting instead that a newly empowered regulatory regime can rein in the big financial players without shackling the markets and drying up the flow of credit to businesses.

“We are poised to pass the toughest financial reform since the ones we created in the aftermath of the Great Depression,” President Obama said on the South Lawn of the White House, before leaving for the Group of 20 meeting in Toronto, where he was expected to press other nations to tighten their financial rules.

Democrats predicted that the full Congress would approve the legislation next week and that they would meet their goal of sending the bill to Mr. Obama for his signature by the Fourth of July.

The financial industry won some important victories, even if they face significantly heightened regulation. They fought off some of the toughest restrictions on their ability to invest their own funds. Most significantly, they thwarted an attempt to make them give up their highly profitable derivatives trading desks. And big lobbying fights remain in the future, when regulators begin the nitty-gritty task of turning complex, sometimes vague laws into real-world rules for these businesses to follow.

Industry analysts predicted that banks would most likely adapt easily to the new regulatory framework and thrive. As a result, bank stocks were mostly higher Friday, prompting some skeptics to question if the legislation, in fact, would be tough enough to rein in the industry and prevent future shocks to the economy as a result of bad gambling.

Even architects of the bill acknowledged that it might take the next financial crisis to truly determine the effectiveness of the changes.

On Friday morning, after a 20-hour final negotiating session, lawmakers, Congressional aides, lobbyists and the banking industry were still sorting through the legislative rubble of a frantic night of deal-making, edits and adjustments that left even some of those who worked most closely on the bill confused about exactly how some of the final details turned out. At points in the debates, lawmakers seemed to have trouble following their own deliberations.

“Can somebody explain to me what’s in Tier 1 capital?” Representative Melvin L. Watt, Democrat of North Carolina, pleaded, referring to the core measure of a bank’s financial strength. “I just don’t have enough knowledge in this area.”

The White House’s desire to get a bill before the Fourth of July break drove the day. At 11 p.m. Thursday, Representative Barney Frank, Democrat of Massachusetts and chairman of the Financial Services Committee who presided over the conference proceedings, began to show signs of impatience. When the senior Republican on the committee, Representative Spencer Bachus of Alabama, asked for another minute to finish a statement, Mr. Frank cut him off. “I would object to that,” he snapped. “Not at 11 o’clock at night.”

As midnight turned to early morning, lawmakers cast rapid-fire votes on amendments hastily scrawled in the margins of rejected proposals. With C-Span carrying the proceedings live, the last half-hour of the session featured sometimes confused lawmakers repeatedly asking about what happened to various proposed amendments.

While the televised proceedings at times provided a remarkable window into the minutiae of legislating, many of the deals to complete the bill were cut outside the conference room, in private discussions between Democratic lawmakers and the Obama administration, with some of Washington’s most influential lobbyists trying to weigh in as best they could.

One major bank on Friday scrambled to figure out what happened to six words that to its surprise and dismay were apparently cut from an amendment on proprietary trading, potentially posing a threat to its business.

The final bill vastly expands the regulatory powers of the Federal Reserve and establishes a systemic risk council of high-ranking officials, led by the Treasury secretary, to detect potential threats to the overall financial system. It creates a new consumer financial protection bureau, and widens the purview of the Securities and Exchange Commission to broaden regulation of hedge funds and credit rating agencies.

The measure restricts the ability of banks to invest and trade for their own accounts — a provision known as the Volcker Rule, for its chief proponent, Paul A. Volcker, the former Federal Reserve chairman — and creates a tight new regulatory framework for derivatives, the complex financial instruments that were at the heart of the 2008 crisis.

But in a late-hour compromise, the bill does not include the tough restrictions on derivatives trading championed by Senator Blanche L. Lincoln, Democrat of Arkansas, which would have forced banks to jettison their most lucrative dealings in this area.

Instead, in a deal negotiated between Mrs. Lincoln and a bloc of House members called the New Democrat Coalition, banks will be required to segregate their dealings only in the riskiest categories of derivatives, including the highly structured products like credit-default swaps based on bundles of mortgage loans, and in certain types of derivatives that are based on commodities that banks are already prohibited from investing in, like precious metals, agricultural products and energy.

But derivatives that have clear business purposes like helping manufacturing companies to hedge against the cost of raw materials or swings in foreign exchange rates would continue to be allowed. And nonfinancial corporations would be allowed to set up their own financial affiliates to create and trade derivatives related to their businesses.

The derivatives deal also headed off a last-minute rebellion by some New York lawmakers concerned about the effect of Mrs. Lincoln’s proposal on Wall Street businesses.

“We wanted to make sure we didn’t drive all the derivative business out of New York,” said Representative Gregory W. Meeks, a Democrat from Queens, who served on the conference committee.

The bill also does not include some of the more draconian proposals debated in recent months, including re-establishing a firewall between commercial and investment banking. And the nation’s auto dealers won exemption from oversight by the new consumer protection bureau, which will regulate most consumer lending.

Some business groups angrily denounced the final product, saying it was ill-conceived and would have unintended consequences harmful to the economy.

“Far from effective reform, this legislation includes provisions totally unrelated to the financial crisis which may disrupt America’s fragile economic recovery and increase instability and risk,” said John J. Castellani, president of the Business Roundtable, which represents chief executives of top American companies.

The conference report approved Friday is subject to approval by both chambers of Congress, a process that is expected to begin on Tuesday with action by the House and then by the Senate — where 60 votes will be required to end debate.

The vote in the conference committee was on party lines, with Democrats in favor and Republicans opposed. House conferees voted 20 to 11 to approve the bill and Senate conferees voted 7 to 5.

Republicans repeatedly complained that the bill would do nothing to tighten regulation of the government-sponsored mortgage companies, Fannie Mae and Freddie Mac, which were at the heart of much of the housing crisis.

Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the banking committee who with Mr. Frank led the negotiations, said the bill would prevent the corporate bailouts required in 2008 and allow the United States to become a global leader in financial regulation, potentially providing decades of stability.

“Never again will we face the kind of bailout situation as we did in the fall of 2008 where a $700 billion check will have to be written,” Mr. Dodd said in an interview. But he acknowledged that the effectiveness of the legislation would be learned only over time.

“I don’t have the kind of ego that would tell you we have absolutely solved these problems,” he said. “We won’t know until we face the next economic crisis.”

Republicans, however, warned that the bill would extend the reach of government too far.

At one point during debate over whether banks should be allowed to trade for their own profit, Representative Jeb Hensarling, Republican of Texas, asked what the issue had to do with the financial crisis. “How much riskier is proprietary trading than investment in certain forms of residential real estate?” Mr. Hensarling asked.

“If we’re not going to bail them out with taxpayer money, what they do with their money is their business.”

He said, adding: “This is one more occasion where we see something in the bill that did not have a causal role in the crisis.”

While regulatory bills often get watered down as they grind through the legislative process and interest groups and industry press for changes, the financial bill mostly gained strength as the debate lengthened and lawmakers seized on public frustration that rich financial institutions, recently bailed out by taxpayers, showed no signs of curtailing their risky practices or their outsize pay packages.

Raymond Hernandez and Binyamin Appelbaum contributed reporting.